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Last week was a brutal eye-opener -- of Un Chien Andalou proportions -- for bulls of Green Mountain Coffee Roasters (Nasdaq: GMCR ) . I should know. I was one of them.
After scaling a wall of worry with every passing quarter, Green Mountain finally proved mortal. The growing chorus of bears arguing that the Keurig business is slowing finally got it right. The stock shed nearly half of its value, as Green Mountain missed its own sales projections and hosed down top- and bottom-line forecasts for the entire fiscal year.
What the bulls are missing
There are some bullish responses that need to be discarded here.
- "Well, at least Green Mountain grew revenue and earnings by 37% and 33%, respectively. That's not too shabby." That may be true, but remember that Green Mountain was targeting net sales to climb as much as 50% higher several weeks into the period. Business deteriorated in the final two months of the quarter, and that's what's important as we eye the company's near-term prospects.
- "Green Mountain is still looking to grow net sales by 45% to 50% this year. That's not too shabby." Again, this is a figure that leans too heavily on the company's success in the past. Net sales more than doubled during the company's first fiscal quarter.
In order to assess where Green Mountain is at the moment, it's a good exercise to slice out the first half of the fiscal year. What does the company's outlook for all of fiscal 2012 -- calling for a profit per share of $2.40 to $2.50 on a 45% to 50% top-line bump -- really mean?
Well, if we remove what the company has already earned and generated in net sales during the first half of fiscal 2012 and compare the balance of the guidance with what the company cranked out during the latter half of fiscal 2011, we get a much clearer picture. Green Mountain's new guidance is telling investors to expect earnings growth of 21% to 31% during the final six months of the fiscal year along with a 23% to 37% increase in net sales.
The instinctive reaction may be that Green Mountain is a bargain even with the sobering near-term projections. Green Mountain at 10 times this fiscal year's lowered earnings guidance is a deep discount to its growth. Unfortunately, we saw how flawed the company's guidance was three months ago. If business is truly deteriorating, more downward revisions will follow.
What the bears are missing
The naysayers have every right to gloat. The bears won last week. Inventory levels are still troublesome, and demand is slipping even before the company tackles K-Cup patent expirations later this year. Analysts may be marking down their profit estimate for fiscal 2012 to match the company's new guidance, but they're giving fiscal 2013 an even bigger haircut. Calls for a profit of $3.68 a share in the new fiscal year that begins in October have been whittled down to $3.15 a share.
The bears clearly have broader bragging rights, but there are also a couple of arguments that they can't fairly make at this point.
- "There's been too much insider selling and secondary offerings here. Investors should've run at the first sign of a secondary." Equity historians will naturally make it a sport to single out the reasons for souring of this growth stock since peaking last summer, but don't blame the secondary offerings. These admittedly dilutive moves helped bankroll the purchase of several leading coffee makers, setting up the company for growth even after the upcoming K-Cup patent expirations. More to the math, the stock closed at a split-adjusted $22.49 the day the first secondary was announced in the summer of 2009. Obviously holding since then hasn't been much of a winning investment, but anyone that saw that as a shorting signal would be at a loss even after last week's plunge.
- "Green Mountain is still overvalued." Really? Let's compare Green Mountain to market daring Starbucks (Nasdaq: SBUX ) . Analysts see Starbucks growing its profitability by 25% in fiscal 2013. Wall Street's new haircut on Green Mountain estimates still have the company growing its net income by 29% in the same fiscal 2013. Green Mountain is fetching less than eight times next year's target. Starbucks is trading at a 24 times next year's earnings. Is the slower-growing Starbucks really worth three times the multiple?
Bears will respond "of course" to that final question. There are plenty of question marks when it comes to Green Mountain. We may be two years removed from an accounting restatement, but fears that Green Mountain stuffed its distribution channels last year -- and are paying the price now -- have yet to be silenced. Inventory control concerns remain, though at least one of last year's bearish knocks has been diminishing. Operating cash flow has more than tripled through the first six months of this fiscal year.
Cynics have grown concerned about discounting in the coffee industry in recent months. They see McDonald's (NYSE: MCD ) selling small coffees on the dollar menu, and wonder if closing the pricing gap with one-cup brewers will sting. They saw closeout retailer Big Lots (NYSE: BIG ) selling select K-Cups brands at markdowns earlier this year. Arabica beans -- after rallying last year -- recently hit a 52-week low, so java in general will get cheaper. Lost in last week's report is that Green Mountain did sell 47% more K-Cups than it did a year earlier at an average price that is 12% higher.
The concerns are real. There are questions still left unanswered. David Einhorn nailed it with his bearish call last year. However, the popularity of Keurig continues to move in the right direction, even if it's no longer moving at the same speed.
September's patent expirations will leave a mark, but the resulting drop in K-Cup prices will only make the platform more popular and nudge Green Mountain toward cashing in on its Keurig patents and licenses as profit centers as its many coffee brands jockey for position.
It may take time for Green Mountain to gain the market's respect, but the valuation -- and Green Mountain's new appeal as a buyout at these levels -- makes this a dangerous time for the shorts to continue high-fiving one another.
Brew ha ha
Shares of Green Mountain have still handily beat the market since I originally recommended the java heavy to Rule Breakers subscribers three years ago. It's lost a lot of ground -- and grounds -- lately, but if you want to discover the newsletter service's next rule-breaking multibagger, a free report tells all. Check it out before it's gone.